AUE2601 STUDY SUMMARY NOTES 2022.

AUE2601 STUDY SUMMARY NOTES 2022. uditing Theory And Practice. The need for Auditing Services Jackson & Stent Chapter 1 ISA 200 – Objectives and general principles governing an audit ISA 610 International Framework for Assurance Engagements External auditors – express an independent opinion if the AFS‟s of a company fairly present the financial position and results of the company‟s operations. NOT an employee of the company. Basically enhances the degree of confidence which users of the financial statements will have of the information they received from the financial statements. Internal auditors – perform independent assignments on behalf of senior management of the company – normally to evaluate the efficiency, economy and effectiveness of the company‟s internal control systems and business activities. Enhances management‟s degree of confidence that the company‟s systems are functioning as intended. Employee of the company, but should be independent of the department, division or subsidiary which they are auditing. Government auditors – evaluate and investigate the financial affairs of government departments and report their findings to senior government therefore increasing the degree of confidence which they have in their departments. Employee of the government, but must be independent of the government department they are auditing. Forensic auditors – concentrate on investigating and gathering evidence where there has been alleged financial mismanagement, theft or fraud. Work independent of the entity under investigation and increases the degree of confidence the investigating body has in the evidence which is presented. 2 Special purpose auditors – specialise in a particular field such as environmental auditors and VAT auditors. Enhance the confidence people have in the “correctness” of the information that is being presented. MUST BE INDEPENDENT OF THE ENTITY BEING AUDITED. Auditor required to observe the fundamental ethical principles of :  integrity (straightforward, honest, moral)  objectivity (impartial, fair, non-biased and non-prejudicial)  professional competence and due care – maintaining professional knowledge and skill at the required level and performing work diligently  professional behavior – comply with laws and regulations and avoid action which discredits the profession  confidentiality – respecting the confidentiality of client information. Financial reporting system is the entire process by which the management of a business entity compiles and discloses financial information concerning their financial position and the results of the entity’s operations. All this information is communicated to external parties in the entities financial statement at the end of each accounting period and the financial reporting process must address the needs of users of the financial information (investors, lenders, suppliers and employees). Information must be understandable, relevant, and reliable and prepared on a basis that is comparable with that used by other business entities. Objective of financial statements = to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions. (From the conceptual accounting framework in the International Standard – IAS). Auditing vs. accounting : Management responsibility to prepare the financial statements in accordance to International Financial Reporting Standards (IFRS‟s) and also to :  maintain an appropriate accounting system and  design and implement adequate internal controls to ensure the reliability and integrity of the accounting system Accounting = the series of tasks and records of an entity by which transactions are processed as a means of maintaining financial records. Auditing = examining audit evidence to find sufficient evidential matter to support the comments of management contained in the financial statements, in order to express an opinion in the auditor’s report as to whether or not the financial statements fairly present the affairs of the entity in accordance with International Financial Reporting Standards and the relevant statutory requirements. AUDITOR THEREFORE EXPRESSES AN OPINION ON MANAGEMENT’S FINANCIAL STATEMENTS. Engagement of auditing can either be because of statutory requirements (e.g. companies) or on a voluntary basis : Statutory audits – audits required in terms of an Act – e.g. Companies Act which state that all companies must be audited on an annual basis. These acts normally spell out the statutory duties and responsibilities of the auditor. Non-statutory audits – audits that are requested by clients but are not obligatory in terms of legislation – e.g. if member wants audit of a CC. Either engaged for : Audits – auditing engagements Related services – review engagements or engagements where agreed-upon procedures are carried out and compilation engagements. Objective of : Audit engagement – to enable the auditor to express an opinion as to whether the financials statement are prepared (in all material respects) in accordance with an applicable financial reporting framework Review engagement – to enable the auditor to state whether or not anything has come to the auditor's attention that causes the auditor to believe that the financial statements are not prepared (in all material respects) in accordance with an identified financial reporting framework. A review engagement is conducted on the basis of procedures that do not provide all the evidence that would be required in an audit. Agreed-upon-procedures engagement – for the auditor to carry out procedures of an audit nature to which the auditor and the entity and any appropriate 3rd parties have agreed and to report on the factual findings Compilation engagement – to use accounting expertise as opposed to auditing expertise to collect, classify and summarise financial information. OBJECTIVE OF A FINANCIAL AUDIT (AUDIT OF FINANCIAL STATEMENTS) – to provide users of the financial statements of companies with a high degree of assurance about the creditability of the assertions made by the management of the company in its financial statements. The assurance is in the form of an expression of an opinion in the auditor’s report as to whether or not the financial statements are a fair presentation of the company’s operating activities. The determination of fair presentation relates to the financial statements taken as a whole. Fair presentation is determined based on the auditor reporting on the information on the financial position (balance sheet), performance (income statement) and any changes in the financial position of the company (cash flow statement). 3 ISA 200 – OBJECTIVE AND GENERAL PRINCIPLES GOVERNING AN AUDIT OF FINANCIAL STATEMENTS Auditor must comply with relevant ethical requirements relating to audit engagements. Audit must be conducted in accordance with International Standards on Auditing, but will also have to comply with other professional, legal or regulatory requirements - ISA‟s do not override local laws and regulations. Auditor should also plan and perform an audit with an attitude of professional skepticism realising that there may be circumstances resulting in the financial statements being materially misstated. Auditor conducting an audit in accordance with ISA‟s has reasonable assurance that the financial statements taken as a whole are free from material misstatement (due to fraud or error). Reasonable assurance allows the auditor to conclude that there are no material misstatements in the financial statements taken as a whole. Management is responsible for identifying risks to the business however the auditor is only concerned with risks that may effect the financial statements. Audit risk = the risk that an auditor may express an inappropriate audit opinion when the financial statements are materially misstated (risk of material misstatement). Detection risk = the risk that the auditor will not detect misstatement of the financial statements. The auditor performs audit procedures to assess the risk of material misstatement and sees to limit detection risk by performing further audit procedures based on that assessment. Risk is a function of the effectiveness of an audit procedure and its application by the auditor and can never be reduced to zero because the auditor never examines the full class of transactions, account balances or disclosure or other factors (e.g. auditor may select an inappropriate audit procedure, misapply an appropriate audit procedure or misinterpret the audit results.) Can normally be addressed through adequate planning, proper assignment of personnel of the engagement team, application of professional skepticism and supervision and review of the audit work performed. Relates to the nature, timing and extent of the auditor‟s procedures that are determined by the auditor to reduce audit risk to an acceptably low level. FOR GIVEN LEVEL OF AUDIT RISK - THE ACCEPTABLE LEVEL OF DETECTION RISK BEARS AN INVERSE RELATIONSHIP WITH THE RISK OF MATERIAL MISSTATEMENT AT THE ASSERTION LEVEL, so the greater the risk of material misstatement that the auditor believes exists, the less the detection risk that can be accepted AND the less risk of material misstatement the auditor believes exists, the greater the detection risk that can be accepted. The audit should be planned and preformed to reduce audit risk to an acceptably low level, by designing and performing audit procedures to obtain sufficient appropriate audit evidence to draw reasonable conclusions on which to base an audit opinion. Reasonable assurance is obtained when the auditor has reduced audit risk to an acceptably low level. The auditor is concerned with material misstatements and isn‟t responsible for detecting misstatements that are not material to the financials as a whole. Auditor must consider risk of material misstatements on two levels :  overall financial statement level – refers to risks of material misstatement relating pervasively to the financial statements as a whole and that potentially affect many assertions. These risks often relate to the entity‟s control environment (e.g. management‟s override of internal controls) but could also be declining economic conditions, but are mainly relevant due to the risk of material misstatement arising from fraud. Auditor must use knowledge, skill and ability of personnel assigned significant engagement responsibilities, appropriate levels of supervision and if there is any event or condition that may cast significant doubt on the entity‟s ability to continue as a going concern.  in relation to classes of transactions, account balances and disclosures and related assertions – assists in determining the nature, timing and extent of further audit procedures at the assertion level. Auditor must have sufficient appropriate audit evidence at class of transactions, account balance and disclosure level so that the auditor at completion of the audit can express an opinion on the financial statements taken as a whole at an acceptably low level of audit risk (can use a model that expresses the general relationship of the components of audit risk in mathematical terms to arrive at an appropriate level of detection risk). Risk of material misstatement at the assertion level consists of :  inherent risk = susceptibility of an assertion to a misstatement that could be material (either alone or in total with other misstatements) assuming that there are no related controls. Greater in some assertions and related classes of transactions, account balances and disclosure (e.g. complex calculations are more likely to be misstated then simple calculations, and accounts estimates subject to significant measurement uncertainly pose greater risks then accounts that have relatively routine factual data.) External circumstances giving rise to business risks can also influence inherent risk (e.g. technological developments can made a product obsolete therefore causing inventory to be susceptible to overstatement). Factors in the entity and its environment can also influence the inherent risk related to a specific assertion (e.g. lack of sufficient working capital to continue operations or declining industry characterised by a large number of business failures.)  control risk = risk that misstatement could occur in an assertion that could be material, either individually or in total with other misstatements, and will not be prevented or detected an corrected by the entity‟s internal control system. Some risk will always exist because of the inherent limitations of internal control – and control risk is a function of the effectiveness of the design and operation of internal control in achieving the entity‟s objectives relevant to the preparation of the financials. Inherent and control risks are risks of the entity – they exist independently from the audit of financials. The auditor is required to assess the risk of material misstatement at the assertion level as a basis for further audit procedures, but that assessment is a judgment rather then a precise measurement of risk. The assessment of the risk of material misstatement can be expressed in quantitive terms (e.g. percentages) or in non-quantitive terms. 4 Auditor’s responsibility = forming and expressing an opinion on the financial statements Management responsibility = preparing and presenting the financial statements in accordance with the applicable financial reporting framework. Must identify that framework and must :  design, implement and maintain internal controls that are free from material misstatement (from either fraud or error)  select and apply appropriate accounting policies  make accounting estimates that are reasonable in the circumstances Financial statements = structured representation of the financial information which are derived from accounting records and are intended to communicate the entity‟s economic resources or obligations at a point in time (or changes therein) for a period of time in accordance with a financial reporting framework, normally including notes. FOLLOWING MIGHT NOT YET BE APPLICABLE (ISA notes say to be implemented at future date) : auditor should determine if the financial reporting framework that management has used in preparing the financial statements is acceptable. Acceptable financial reporting frameworks for general purpose financial statements normally show :  relevance  completeness  reliability  neutrality  understandability If auditor makes comparison of the entity’s financials against the requirements of an existing framework and differences are identified, then must consider the reasons for the difference and if the application of the accounting convention could result in misleading financials. If auditor decides that the framework used by management is not acceptable – then must consider the implications in relation to engagement acceptance and the auditor’s report. Expressing an opinion on the financials – refer to ISA 700 (revised), 701 and 800 when expressing an opinion, but ISA is only effective for audits of financials on or after 15 th December 2005! Amendment to ISA 200 states that auditor can (in exceptional circumstances) depart from a basic principle or an essential procedure in order to achieve the objective of the audit. In that case the auditor may still represent compliance with ISA‟s provided the departure is appropriately documented. Advantages of audit of financial statements – assures the creditability of the financial statements to various users such as:  banks and loan giving companies  SARS for tax collection  investors who base investment decisions on auditing info  employers relying on audited info when taking decisions affecting employee benefits  creditors for decisions regarding the extending of trade credit  settlement of claims e.g. insurance claims Audit helps auditor to advise the company on :  improvements to the accounting system if necessary  ways of increasing efficiency and profits Auditors offer either assurance engagement or non-assurance engagement services : Assurance engagements In terms of International Framework for Assurance Engagementsan assurance engagement is where a professional accountant (auditor) expresses a conclusion that will enhance the degree of confidence in the intended users about the outcome of the evaluation or measurement of subject matter against the criteria. i.e. the registered auditor assures the shareholders that the directors responsible for the AFS‟s have compiled accurate results of operations and that the financial position of the company complies with the International Financial Reporting Standards.  audit of financial statements – assurance engagements – registered auditor gathers sufficient appropriate evidence to pass an opinion on whether the directors have applied the International Financial Framework appropriately in present fairly the financial position, performance and cash flow of the company for the financial year  other assurance engagements :  to report on the effectiveness of a client‟s internal control system (must measure against the criteria)  to report on whether the client is complying with the requirements of the Sarbannes-Oxley Act 2002 relating to corporate governance Non-assurance engagement Any other engagements that don‟t meet the definition of an assurance engagement – e.g. might not be a 3 rd party involved or there may not be any suitable criteria (benchmarks) against which to measure the subject matter of the engagement. So therefore the auditor will not express an opinion or comment on the subject matter of the engagement. Reasonable assurance – auditor doesn‟t certify or confirm the absolute correctness of financial information, instead expresses an opinion on its fair presentation (cos audit is to provide reasonable assurance that the financial statements taken as a whole are free of material misstatement NOT that they are 100% correct. 5 ISA – Objective and General Principals provides list of factors :  use of testing – auditor cannot examine every single transaction in the business so does “test check” (check a sample of transactions and balances). Obviously If has only test checked then can‟t say that everything is 100% correct cos hasn‟t tested everything.  inherent limitations of account and internal control systems – auditor has to rely on the client‟s systems to provide financial information and these systems will have limitations which may result in failure to detect errors or frauds (so information that auditor is using to supply an opinion may be flawed.)  audit evidence is usually persuasive rather then conclusive – auditor can only be “persuaded” that an event or transaction took place by looking at the documents or information that management provides. Didn‟t actually witness the event  subjectivity in the financial statements and in the auditor’s approach to the audit – many account balances in the financials contain balances which are subjective (fixed) and many current assets are affected by estimates (subjective) of depreciation impairment, stock obsolescence and bad debts. Cos impossible for auditor to know which debtors will not pay or which stock will become obsolete so the auditor‟s decisions as to which type of tests and the timing and extend of those tests will all be subjective – i.e. one auditor will not necessarily conduct the audit in the same way as another auditor. Assurance engagements broken up into :  reasonable assurance – objective is reduction in assurance engagement risk to an acceptably low level in the circumstances of the engagement as the basis for a positive form of expression of the practitioner‟s conclusion  limited assurance engagements – objective is reduction in assurance engagement risk to a level that is acceptable in the circumstances of the engagement, but where the risk is great then for a reasonable assurance engagement as the basis for a negative form of expression of the practitioner‟s conclusion. Differences between reasonable assurance engagements and limited assurance engagements Reasonable Assurance Engagements Limited Assurance Engagements Objective Reduction in assurance engagement risk to an acceptably low level in the circumstances of the engagement as the basis for a positive form of expression of the practitioner‟s conclusion Reduction in the assurance engagement risk to a level that is acceptable in the circumstance of the engagement, but where the risk is greater then for a reasonable assurance engagement as the basis for a negative form of expressing of the practitioner‟s conclusion Evidence gathering procedures Sufficient appropriate evidence obtained as part of a systematic engagement process including :  obtaining understanding of the engagement circumstances  assessing the risks  responding to the assessed risks  performing further procedures using combination of :  inspection  observation  confirmation  recalculation  re-performance  analytical procedures  inquiry using substantive procedures including corroborating information and tests of the operating effectiveness of controls if necessary  evaluating the evidence obtained Sufficient appropriate evidence is obtained as part of a systematic engagement process that includes obtaining an understanding of the subject matter and other engagement circumstances, but in which procedures are deliberately limited relative to a reasonable assurance engagement Assurance report Description of the engagement circumstances and a positive form of expression of the conclusion Description of the engagement circumstances and a negative form of expression of the conclusion Read International Framework for Assurance Engagements Elements of an Assurance Engagement pgs 287-300 for definitions and information on the following elements :  three party relationship (practitioner, responsible part and intended users)  subject matter  criteria (benchmarks with relevance, completeness, reliability, neutrality and understandability)  evidence (taking into account professional skepticism, sufficiency and appropriateness of evidence, materiality, assurance engagement risk, nature and timing and extent of evidence-gathering procedures and quantity and quality of available evidence)  assurance report 6 Audit therefore provides REASONABLE assurance that the financial statements taken as a whole are free from material misstatement, but cannot provide ABSOLUTE assurance that the financial statements are free from any misstatements. Always limitations on an audit cos of :  use of testing / sampling  inherent limitations of any accounting and internal control system  audit evidence is often persuasive rather then conclusive  auditor‟s work is governed by his judgment, especially regarding :  gathering of audit evidence (nature, extent and timing of audit procedures)  drawing of conclusions based on the audit evidence gathered  other limitations that can affect the persuasive force of available evidence – e.g. transactions between related parties. Auditing postulates (auditing basis of thinking or starting point of auditing) :  no conflict of interest between the auditor and management / employees of the entity being audited – so everyone wants the audit to prove that the financial statement are a fair presentation, but that if management doesn‟t want a fair presentation (i.e. to hide fraud or to make the company appear more favourable financially) then it is impossible for a normal audit. Therefore the auditor may have to view management‟s integrity with professional skepticism and should not just take what is said by management as being the truth  auditor must act exclusively as an auditor in order to offer an independent and objective opinion on the fair presentation of financial information (i.e. the auditor‟s opinion can only be relied upon if is free of bias (independent) and has devoted all his energy to the audit  professional status of the independent auditor imposes commensurate professional obligations – professional auditor has to live up to expectations of due care, service before personal interest, efficiency and competence and have responsibility as professional practitioner  financial data if verifiable – difficult to verify paperless transactions or e-commerce transactions and therefore cannot get a level of assurance by verifying the financial data so can‟t form opinion on fair presentation of the financial information  internal controls reduce the probability of errors and irregularities – so the better the internal controls and checks the higher the chance that the financial information is “truthful”. If no internal controls then auditor might be forced to refrain from offering an opinion or to conduct an extremely detailed audit examination. Without internal control the financial data is not verifiable  application of IRFS results in fair presentation – so if stick to the suggested framework then there will be fair financial presentation. Auditor‟s opinion is therefore based on a generally accepted standard and not on personal preferences and the auditor has something against which to judge the fairness of the financial information for the audit  that which held true in the past will hold true in the future (in the absence of contrary evidence) – historical evidence is crucial. Decisions about the future are made and accounted for on the basis of historical information and could even say that the integrity of the entity‟s director do not alter from year to year. Auditor has to draw on past experience when assessing judgments about the future, but that doesn‟t mean that things don‟t change  financial statements submitted to the auditor for verification are free of collusive and other unusual irregularities – so the auditor take assume that management has taken adequate steps to ensure that the statements are “correct” and that employees and members of the management team haven‟t colluded in the presentation of the financial statements. Cynical view now might be that managers and employees are not always honest and that this postulate is no longer true, however if the auditor didn‟t assume that the financial statements are “correct” then the objective and the focus of the audit would change from an opinion on fair presentation to a search for fraud and other irregularities. SA Institute of Chartered Accountants (SAICA) says professional has certain characteristics including :  mastery of a particular intellectual skill acquired by training and education  acceptance of duties to society as a whole in additional to duties to the client or employer  outlook which is essentially objective and  rendering personal services to a high standard of conduct and performance. SA Institute of Chartered Accountants (SAICA) Independent Regulatory Board for Auditors (IRBA) In terms of Auditing Professional Act, anyone wanting to offer auditing services must be registered with IRBA. People registered with IRBA are then “registered auditors”. Only people registered in terms of the Auditing Professions Act 2005 can practice as independent auditors. see definition of audit on pg 1/13 of text book AUDIT OBJECTIVE IS TO EXPRESS OPINION ON WHETHER THE FINANCIAL STATEMENTS ARE FAIRLY PREPARED IN ACCORDANCE WITH THE FINANCIAL REPORTING FRAMEWORK. AUDITOR‟S OPINION IS NOT ASSURANCE OF THE FUTURE VIABILITY OF THE ENTITY OR THE EFFICIENCY OF MANAGEMENT IN RUNNING THE AFFAIRS OF THE ENTITY